Following a series of natural disasters – from the Canterbury earthquakes to Cyclone Gabrielle – some New Zealand homeowners are left with real doubts about the insurance options available to them.
In some areas, homes are increasingly uninsurable – or at least almost impossible to insure. Insurers have decided that the risk is too high to justify insurance financially. This puts the affected homeowners at risk.
The question of how insurers can continue to offer policies while managing the increasing risk posed by natural disasters is becoming increasingly difficult to ignore.
If New Zealand is to adapt to future changes, insurers must explore alternative models and innovate.
Cautious insurers
In New Zealand, there is no general requirement that insurers must insure anyone’s home, or that anyone’s home must be insured at all.
One exception is homeowners’ associations. They must insure the units they manage. Mortgage lenders can also require borrowers to take out building insurance as part of their loan terms.
When homeowners purchase insurance, the risk of certain losses from natural disasters is automatically covered by the Natural Hazards Commission (formerly known as the Earthquake Commission).
Even if a building insurance policy contained a wording that ostensibly excluded this public natural disaster protection, the law would consider this protection to be included. At the same time, the payouts are only administered by the insurers, not financed by them.
The Canterbury earthquakes cost insurers NZ$21 billion and the Natural Hazards Commission $10 billion. And the broader risk of natural disasters may be making insurers overly cautious. They are increasingly pulling out of what they consider to be “high-risk” areas.
However, changes are on the horizon. From mid-2025, insurers will have a general duty to “treat consumers fairly”. The Financial Markets Authority – the body responsible for enforcing financial market law – could potentially view refusing consumers home insurance as a breach of this duty.
In other words, financial market regulators could ultimately force insurers to insure the majority of the country’s homes.
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New insurance options
Creating future-proof home insurance options requires collaboration between the public and private sectors.
Many of the possible solutions depend on how insurers take risk. An insurer may lower your premiums to encourage you to “disaster-proof” your home. If you don’t, the insurer may raise your premiums and limit its payouts to you with individual deductibles or maximums.
The insurer can even offer a “parametric” insurance policy that pays out less but faster than a conventional insurance policy.
For example, imagine a home insurance policy that covers all earthquakes whose epicenter is within 500 kilometers of your home and whose magnitude is six or higher.
With a traditional policy, the payout would be based on the amount of the loss (as determined by the claims adjuster). With a parametric policy, only a small, pre-agreed amount would be paid out based on the fact that the earthquake occurred at all.
With a parametric policy, you would not have to prove any actual “loss” – other than the inconvenience of your home being in the disaster zone.
Although parametric insurance is relatively new worldwide, it represents an efficient solution for managing the risk of losses caused by natural disasters.
Reinsurance, co-insurance and catastrophe bonds
An insurer may also transfer the risk to one or more other insurance companies – for example, a “reinsurer”. If the insurer has to pay you a claim, the reinsurer must pay a portion of it to the insurer.
The insurer may even “co-insure” the risk. Co-insurance is when two or more insurers cover different parts of the same risk. So if you co-insure your home, two or more insurers are responsible for part of a claim.
In addition, it is possible to transfer insured risks to companies that are not even insurance companies. In some countries (such as Bermuda, the Cayman Islands and Ireland), the insurer can convert the risk into a “catastrophe bond” (also called a “cat bond”).
With a catastrophe bond, the insurer arranges for experienced investors to lend it capital in return for interest on the loans. The insurer ultimately pays back the capital unless a specific natural disaster occurs. In this case, the insurer keeps the capital and can pay it out to the affected customers.
The insurer can even use the catastrophe bond to create a “virtuous circle.” More specifically, the insurer can reinvest the capital in “a project that reduces or prevents losses from the insured climate-related risk (such as flooding).”
Disaster protection for the insurance industry
The key to improving the situation will be cooperation between the public and private sectors to ensure that climate-related disasters become less frequent – and less severe when they occur.
The United Nations Intergovernmental Panel on Climate Change has made recommendations on how individual sectors can minimise climate-related risks, but similar progress is needed in minimising the overall risk of damage from natural disasters, particularly earthquakes.
It’s important to build homes that are more disaster-proof. And it’s also important to address a big problem that many people don’t necessarily associate with insurance: housing costs.
If New Zealanders who want to own a home didn’t have to invest so much money in property, the risk of damage to their homes might be less of a concern. Natural disasters wouldn’t cause financial disasters as often as they do today.
Meanwhile, innovative insurance options are becoming increasingly necessary.
